Understanding business cash flow

Profit is an opinion; cash is a fact

Your profit and loss statement records income when it is earned and expenses when they are incurred — not when the money actually moves. An invoice raised in March counts as March income even if the customer pays in June. That is proper accounting, and it is the right way to measure performance.

But rent, wages and the ATO are paid with cash, not with accounting entries. This is why a business can show a healthy profit and still struggle to pay its bills — and, less comfortably discussed, why a business can sit on plenty of cash while quietly making a loss.

Where the cash actually goes

When a profitable business runs short of cash, the money is usually hiding in one of a few predictable places.

• Debtors

  Work you have done and invoiced but not been paid for. Every dollar in your debtors ledger is a dollar of profit you cannot spend yet.

• Stock

  Goods on the shelf are cash in another form. Over-ordering ties up money that could be paying bills.

• Tax timing

  GST, PAYG and income tax are often paid well after the income they relate to was earned — and spent. The bill arrives just when it is least welcome.

• Growth

  New staff, more stock, bigger premises — expansion absorbs cash months before the extra revenue lands.

Seeing it coming

The fix is not complicated, but it does need to be a habit. A rolling cash flow forecast — a simple projection of the money expected in and out over the next few months — shows the tight spots while there is still time to do something about them: chase invoices, delay a purchase, or arrange finance from a position of strength rather than urgency.

Modern accounting software does much of this automatically, and your accountant can help you set up a forecast that suits the rhythm of your business. Set aside the GST and tax component of your income as it arrives, and the ATO's timetable stops being a source of surprises.

When to get help

If the bank balance regularly feels out of step with what the accounts say, that is worth understanding rather than living with. Sometimes the answer is a simple timing issue; sometimes it points to pricing, terms or costs that need attention. Either way, it is a conversation your accountant has had many times before.